Coal, gas track upward: one as price floor, other as its ceiling

Coal, gas track upward: one as price floor, other as its ceiling

Washington (Platts)--15Sep2006

As coal and natural gas prices track on a generally upward trend through 2010,
coal provides the floor for natural gas prices and gas sets a "modest ceiling"
for coal, said one speaker Thursday at the Platts Coal Marketing Days. The
margins will stay tight, which could drive some smaller producers out of the
business.

David Khani, managing director and co-head of energy and natural resources for
Friedman, Billings, Ramsey & Co., predicted that Central Appalachian coal
margins will continue to narrow through 2007 and then start to widen again.
But at the near-term level, smaller coal companies will have no margins.

There is stable demand for coal and gas, with the long-term floor set by the
marginal cost of production, he said.

Powder River Basin spot prices are about $7/st in the third quarter, and
producers are not making much money. FBR predicts that PRB margins will expand
to $3 to $4/st eventually.

Khani believes the real competition will be when natural gas costs $5/MMBtu to
$6/MMBtu. The long-term trend is for natural gas to decline in price, and
supply will not grow.

Natural gas now costs $5.50/MMBtu at Henry Hub and marginal producers cannot
make money with gas at that price, he said.

Khani predicted that the correlation between coal and natural gas prices would
continue to solidify.

But, taking the minority position, Seth Schwartz, principal of Energy Ventures
Analysis, said there is "virtually no relationship between coal prices and
natural gas prices." The correlation is through other factors, such as
railroad deliveries and the effects of Hurricane Katrina last year. Gas prices
are higher and more volatile, and coal and gas are not in a battle for market
share.

The railroad capacity in the PRB limited supply, and that in turn led to a
price spike and building inventories.

But that price spike is over now, he said.

Coal markets are regional in nature, Schwartz said, and the prices are set by
producers in the region. Rail rates are going to stay high and that means
increased regional markets for coal. He predicted an increased market for Ohio
River coal when scrubbers are built.

Looking at the cash costs of coal, Perry Bissell, director of energy analysis
at John T. Boyd, said that often, when coal prices drop off, coal companies
actually produce more coal, thereby dropping the unit price of coal. Among the
steps taken, which vary by underground or surface mining, are eliminating
expansions, pulling out of high-cost areas, deferring maintenance and
rebuilding equipment and stopping permitting.

Looking out six months to a year, the result is that the best resources are
used up, low-ratio coal is gone and the company is left with high-cost coals
and equipment that needs maintenance.

Bissell said coal companies' biggest worry is states' initiatives on
regulating mercury.

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